Shares in UK-based Tricorn Group (LON:TCN) today slumped 40% in early trade as a trading update revealed that an increase on tariffs on their products entering the US from China have led to delays as prices are renegotiated. The share price dived but has since recovered, but still leaves us well down on the day so far:
Tricorn would have been a mediocre investment for longer-term holders. Since debuting in 2001, the share price has seen extreme volatility and could be deemed to be roughly cyclical, dropping as low as 4.25p and threatening 40p at one stage with no real trend. Negligible dividends have been paid in this time. Last year one was paid, but for an amount of 0.2p this was not enough to get investors excited.
Tricorn are a group of companies, all specialising in tubing, specifically customised tubular assemblies. There are plenty of applications for this as demonstrated by their operating systems, in Energy and Transportation. Rather than grow organically its method of expansion has been to acquire other small niche companies.
What’s gone wrong at Tricorn?
The trading update today makes reference to two main reasons. The first:
The Period started encouragingly with the new paint facility in the USA integrating well and ahead of plan. Demand in the USA has remained broadly in line with expectations, but the USA operation has seen some short-term pressure on margins. This has been due to a lag between the impact of the increase in tariffs in the USA on goods sourced from China and the time taken to negotiate price increases with customers.
There is a certain irony in this, in that ‘The Donald’ was adamant that China would be bearing the brunt of tariffs. In all likelihood it seems both sides will have to take a hit. Products here would come under ‘building materials’ and be hit with a 25% tariff. This is significant for Tricorn as North America accounted for £10.6m of its £22m turnover last year.
We also have a sharp drop-off in the UK:
In the UK demand slowed significantly through the second quarter resulting in revenue for the Period being around 12% lower than the six months ended 30 September 2018 (the “Corresponding Period”).
This is a common theme across many industries. Robert Walters (a recruitment company) reported a similar decline yesterday. The profit warning is therefore not surprising:
There is a strong pipeline of opportunities and the Board continues to evaluate the impact of new business inload and the extent to which this can offset the impact of weaker underlying market conditions. However, the Board now anticipates that full year results will be materially lower than market expectations.
There are no new broker notes to guide us on this, but there was one (available on Research Tree) at the time of the last results, which estimated this years profit before tax to be £1.1m, which was up from £0.8m. Given that that turnover may be lower than last year it seems as if profits will come in at lower than this figure as well.
Flat Top Line Revenues, Spending Cash
Tricorn could be perhaps described as a turnaround story. There has been little in terms of revenue growth over the years but there has been a trend towards profitability (figures taken from Stockopedia)
Suggesting that either operational efficiencies have come into play, or higher margin products. As the research note suggests, there could be a large degree of operational gearing at play and an uptick in sales could lead to a disproportionately large increase in profits as many costs are already fixed.
This also isn’t a business where cash is being accumulated. Capital expenditures have eaten up the majority of what has been generated by operations, and whilst it is not the case that cash has been drained out of the business and needs to be replaced, the cash balance has gone nowhere: in effect treading water.
The company carries debt, which has not been repaid. The amount on the last financial statements was £3.6m and with an interest charge of £246k we can see this is not a cheap loan. A look at the notes says this is an invoice discounting facility, and typically interest rates for these are fairly high. The accounts note that interest rates paid are up to 12%.
The balance sheet shows a positive tangible asset value – there is £4.67m in property, plant and equipment, but it does not seem feasible that any of these could be sold to repay debt. Given the number of acquisitions it has made, there are very little intangibles on the balance sheet and depreciation charges are small.
Limitations of Size
At a market cap of just £4m, this is one of the smaller companies covered here. Buying in, and conversely selling out will be quite difficult. There is also the possibility of a firm being de-listed at this stage as there seems to be very few benefits of using the stock market.
On a price to earnings ratio, this appears very cheap, although many sites will be still using the old forecasts to calculate a forward P/E, and the profit warning today pretty much makes it known that those forecasts will not be met.
Due to operational gearing, a decrease in turnover could be quite bad for profits. A 10% cut, for instance may be enough to see any profits wiped out altogether. While the RNS stops short of mentioning numbers this sort of scenario is a possibility.
The reasons mentioned in the profit warning also appear to be quite ominous in the sense that they are not short-term fixes. I believe that the US-China tariff war will rumble on for some time yet, and in the UK economic uncertainty will not simply disappear on 31 October.
Debt is the main worry here, whilst it is possible it could be taken over a look at the share price chart shows there were no takers in the past few years. The next set of results could be very important, and I would not want to hold the shares before then. 2/5.